MA – May 2017 – L2 – Q3b – Decision making techniques

Describe the target costing process and outline possible steps to reduce a target cost gap.

Question

Wham Limited assembles and sells many types of android smartphones. It is considering extending its product range to include window phones. These smartphones produce better sound quality than traditional keypad phones and have a large number of potential additional features not possible with the previous technologies (station scanning, more choice, one-touch tuning, station identification text, and song identification text, etc.).

Android smartphones are produced by assembly workers assembling a variety of components. Production overheads are currently absorbed into product costs on an assembly labor hour basis. Wham Limited is considering a target costing approach for its new window phone product.

Required:

i) Briefly describe the target costing process that Wham Limited should undertake in order to successfully introduce its new window phone. (3 marks)

ii) Assuming a cost gap was identified in the process, outline possible steps Wham Limited could take to reduce the target cost gap. (3 marks)

Answer

i) Target Costing Process:

The target costing process includes the following steps:

Identification of a Product:
- Explanation: Target costing begins by specifying a product the organization wishes to sell. This involves extensive customer analysis to understand which features are valued by customers and which are not. The goal is to include only those features that add value to the product.
Determination of the Selling Price:
- Explanation: The price at which the product can be sold is determined, considering competitor products and market conditions at the time of the product launch. This step emphasizes external (competitor) analysis before considering internal cost structures.
Determination of the Target Cost:
- Explanation: From the determined selling price, a desired profit margin is subtracted to arrive at the target cost. The organization aims to meet this target cost to achieve the desired margin. Costs are then calculated and compared to the target cost.
Determination of the Cost Gap:
- Explanation: If the calculated costs exceed the target cost, the difference is known as the cost gap. The organization must identify ways to reduce costs to close this gap and meet the target cost.

(3 marks)

ii) Steps to Reduce the Target Cost Gap:

If a cost gap is identified, Wham Limited can take the following steps to reduce it:

Review Product Features (Value Engineering):
- Explanation: Remove or simplify features that add cost but do not significantly add value to the product from the customer’s perspective. This process is known as value engineering or value analysis.
Team Approach (Brainstorming):
- Explanation: Involve a cross-functional team from marketing, design, assembly, and distribution to brainstorm cost-reduction strategies. Collaborative efforts can identify areas where costs can be minimized without compromising quality.
Review the Supply Chain:
- Explanation: Analyze each stage in the supply chain to identify potential cost savings. This includes negotiating with suppliers, exploring alternative materials, and improving production efficiency.
Increase Productivity:
- Explanation: Enhance productivity by optimizing labor practices, reducing waste, and considering automation. This can spread fixed costs over a larger number of units, reducing the per-unit cost.

(3 marks)

Tags: Cost gap reduction, Cost Management, New product introduction, Product pricing, Target costing
Level: Level 2

Topic: Decision making techniques
Series: MAY 2017

Uploader: Dotse